Record debt levels in Ontario may translate into higher borrowing costs for Canada’s largest province relative to other regional governments.

The province’s net debt will rise to C$220 billion ($216 billion) in 2010-11, or a record 37 percent of gross domestic product, according to budget documents released yesterday. That’s almost twice as high as the debt-to-GDP ratio in British Columbia.

The province, home to 13.1 million people who account for more than a third of Canada’s economy, outlined plans to balance its budget in eight years. Standard & Poor’s last year cut the province’s credit rating on concern over escalating debt as the global recession buffeted the manufacturing industry, which accounts for almost a fifth of output.

“The government’s challenges remain formidable,” Mary Webb, a senior economist at Bank of Nova Scotia in Toronto, said in a note to clients. “Over the next eight years it must accomplish substantial fiscal repair.”

Finance Minister Dwight Duncan tabled a $125.9 billion budget that had little in the way of new spending or direct cuts to programs but promised to reduce the deficit by half in five years and eliminate it completely in eight.

The finance minister called the budget "realistic and responsible" and said it represents a balance between economic responsibility and encouraging a healthy economy.

Savings

Two-year wage freezes for about 350,000 non-unionized public sector workers and a two-year extension of a pay freeze for MPPs introduced last year. Combined, the moves will save $750 million.

Slowing the pace of Toronto's Metrolinx transit projects, resulting in savings of about $4 billion over the next five years. Transit lines needed for the 2015 Pan American Games remain on schedule.

Slowing long-term infrastructure investments for a savings of more than $1.4 billion over the next five years.

Canceling the $174 million bus replacement program for municipalities.

Investments

$63.5 million to make up a gap in federal investment in child care, which will preserve 8,500 child care spaces.

$150 million a year over three years to help industries in Northern Ontario reduce energy costs.

$45 million over the next three years for skills training to help aboriginal residents and northern Ontarians find work.

A permanent energy tax credit to help residents of Northern Ontario with high energy bills.

The introduction of full-day kindergarten for four- and five-year-olds, beginning in September 2010 with up to 35,000 children and across the province by 2015-16.

Unrealistic and Irresponsible

Minister Dwight Duncan called the budget 'realistic and responsible'.

Cower in fear when you hear talk like that from any politician. The savings total is $6.324 billion. A mere $750 million comes from wage "freezes".

On the investment side notice how Duncan does not put a cost on energy tax credits or the introduction of full-day kindergarten for four and five-year-olds. I guess those services pay for themselves.

Duncan does itemize $0.259 billion in other investments.

Thus Duncan proposes to plug a $21 billion shortfall with a net total of about $6 billion in savings. He has the gall to call this 'realistic and responsible'.

Ontario Finance Minister Dwight Duncan is calling on municipal governments to follow the province's lead and clamp down on wages. In Thursday's budget presentation, Duncan announced a freeze for some provincial workers. On Friday, he strongly hinted that he expects municipalities to follow suit.

“We will not be funding increases in overall compensation,” Duncan said.

“Is it cynical or is it shrewdness? Pick your descriptor,” David Docherty, a Wilfrid Laurier University political scientist, said Friday. “There is a lot of politics in this, there are a lot of optics in this,” Docherty said.

For most provincial employees the wage freeze does not kick in for years. About 750,000 provincial workers will not be affected until after their contacts expire. About 310,000 non-union workers will face an immediate wage freeze.

The province gave the Ontario Provincial Police wage increases that totaled more than 12 per cent over three years. Registered nurses in hospitals will see their compensation package increase by 13.4 per cent over three years. Secondary school teachers signed a four-year contact that increases their pay by 12 per cent. College teachers got a three-year contract that increases salaries by nearly six per cent.

“What are they freezing?” Waterloo Mayor Brenda Halloran said.

What are they freezing?

Good question.

The answer is something like 1/10th of a portion of a portion of something, effective years from now, much like a budget freeze in US Congress.

Ontario Finance Minister Dwight Duncan tabled a budget on Thursday that mapped a slow road to balancing the province's books, projecting deficits until 2017-18 and offering little in the way of new spending or direct cuts to programs.

It froze wages for non-unionized public sector workers for two years, but also referred indirectly to unionized public sector workers when it based its deficit projections on no increases in future collective bargaining agreements.

Ontario Public Sector Employees Union president Warren (Smokey) Thomas said the plan sets up adversarial negotiations in the future, particularly in light of the province's plan to increase hospital budgets by only 1.5 per cent, or about half of what the Ontario Hospitals Association said was needed to maintain the status quo.

"We are disappointed that the government would declare, without consultation, that thousands of these workers will see their incomes go down for the foreseeable future, or lose their jobs," said Thomas.

California had $83.5 billion in long-term bond debt, with most of the debt, $64 billion, in general obligation notes, which are financed by the state's general fund.

Bill Watkins, executive director the Center for Economic Research and Forecasting at California Lutheran University in Thousand Oaks, Calif., agreed and urged state officials to begin discussions with the Obama administration and the Federal Reserve in case California defaults on its debt.

"In my opinion, California is now more likely to default than it is to not default," Watkins wrote in an economic forecast released Dec. 16. "It is not a certainty, but it is a possibility that is increasingly likely."

Total Debt Comparison

Ontario's net debt is C$220 billion ($216 billion). California has $83.5 billion in long-term bond debt. Of course we probably need to factor in California's share of US national debt and the same for Ontario.

Regardless of how you slice it, both California and Ontario are fiscal disasters. A case can be made that Ontario is much worse than California. So when you hear all this talk about how much worse California is than Greece, just remember, so is Ontario.

Canadian Banks vs. US Banks Comparison

I continually hear a lot of hot air, mainly from hyperinflationists, about how safe Canada is, how sound its currency is, etc. For the best written rebuttal to date of such talk, please consider The Canadian Banking Fallacy on the Baseline Scenario blog.

Despite supposedly tougher regulation and similar leverage limits on paper, Canadian banks were actually significantly more leveraged – and therefore more risky – than well-run American commercial banks. For example JP Morgan was 13 times leveraged at the end of 2008, and Wells Fargo was 11 times leveraged. Canada’s five largest banks averaged 19 times leveraged, with the largest bank, Royal Bank of Canada, 23 times leveraged. It is a similar story for tier one capital (with a higher number being safer): JP Morgan had 10.9% percent at end 2008 while Royal Bank of Canada had just 9% percent. JP Morgan and other US banks also typically had more tangible common equity – another measure of the buffer against losses – than did Canadian Banks.

If Canadian banks were more leveraged and less capitalized, did something else make their assets safer? The answer is yes – guarantees provided by the government of Canada. Today over half of Canadian mortgages are effectively guaranteed by the government, with banks paying a low price to insure the mortgages. Virtually all mortgages where the loan to value ratio is greater than 80% are guaranteed indirectly or directly by the Canadian Mortgage and Housing Corporation (i.e., the government takes the risk of the riskiest assets – nice deal if you can get it). The system works well for banks; they originate mortgages, then pass on the risk to government agencies. The US, of course, had Fannie Mae and Freddie Mac, but lending standards slipped and those agencies could not resist a plunge into assets more risky than prime mortgages. Let’s see how long Canada resists that temptation.

The other systemic strength of the Canadian system is camaraderie between the regulators, the Bank of Canada, and the individual banks. This oligopoly means banks can make profits in rough times – they can charge higher prices to customers and can raise funds more cheaply, in part due to the knowledge that no politician would dare bankrupt them. During the height of the crisis in February 2009, the CEO of Toronto Dominion Bank brazenly pitched investors: “Maybe not explicitly, but what are the chances that TD Bank is not going to be bailed out if it did something stupid?” In other words: don’t bother looking at how dumb or smart we are, the Canadian government is there to make sure creditors never lose a cent. With such ready access to taxpayer bailouts, Canadian banks need little capital, they naturally make large profit margins, and they can raise money even if they act badly.

Proposing a Canadian-type model to create stability in the U.S. is, to be blunt, nonsense.

There’s no doubt that during the coming months many people will advocate some form of a Canadian banking system in America. Our largest banks and their lobbyists on Capitol Hill will love the idea. For some desperate politicians it may become a miracle drug: a new “safer” system that will lend to homeowners and provide financing to Washington, while permitting politicians and regulators to avoid tough steps. Let’s hope this elixir doesn’t gain traction; smaller banks with a lot more capital – and able to fail when they act stupid – are what U.S. citizens and taxpayers really need.

Canada did not avoid a crisis because their banks were better or smarter or used less leverage. Canada avoided a crisis because for whatever reason, their housing bubble did not yet blow sky high. However it will, and Canada's banking crisis is yet to come.

Disclaimer:The content on this site is provided as general information only and should not be taken as investment
advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security
or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this
site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated
with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that
you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your
investment adviser before making any investment decisions.